The bogey of bank privatisation has been raised again, this time by Arvind Panagariya, Chairman of the 16th Finance Commission. Speaking recently at a FICCI forum, he said: “Privatisation of banks is an important part of reform that is required so that we get out of the cycle of NPAs.” (businessline, August 8; https://shorturl.at/CyrQk) While the reference to the experience of NPAs (non-performing assets) is not incorrect, this is only a part of the story. What Panagariya fails to mention is the cycle of private bank failures that is a common occurrence worldwide.

Panagariya has been in the US from the mid-1970s till now. This period is marked by the reassertion of big capital as the dominant force, the waning of the interests of labour, the primacy of shareholders’ interest (Milton Friedman et al), globalisation at an unprecedented scale, and market domination by a few players in category after category under the guise of free markets. Intellectuals raised in this milieu recommend this ideological path wherever they go. The commentary on bank privatisation has to be seen against this background.

Pay attention to history

In the world of banking, the lessons of history are often missed. In 1906, the colonial city of Madras was shaken by the failure of a bank called Arbuthnot and Company. Although not identified as a bank in its name, the company fulfilled all the functions of a bank. It took deposits and invested in commercial activities.

The 100-year-old establishment, with a magnificent office, employed between 11,000 and 12,000 people. The reputation of the person who headed the firm, Sir George Arbuthnot, was legendary. The bank had nearly 7,000 depositors with over ₹3 crore deposits, a huge amount when a middle-class income was ₹100 a month.

On October 22, 1906, the bank shut shop. The depositors lost everything. The failure was due to three factors: a) application of depositors’ funds into commercial activities that incurred losses (NPAs in today’s language); b) misappropriation of funds (fraud); and c) intricate shuffling of the ledgers to cover mistakes (deception). (Source: The Fall of Arbuthnot and Company, by Rangaswamy Srinivasan). Before one thinks that this is an odd example from history, we should review the situation of bank failures in the current context.

Bank failures in US in 2023

Last year was not a good one for US banking, as many big banks failed. However it was not an unusual year, since hundreds of banks have failed in that country over the decades (see Table). All the banks that failed are private banks, the very type of ownership that Panagariya recommends for India.

Here are the banks that failed in 2023 alone:

Silicon Valley Bank, Santa Clara, California: With more than $209 billion in assets, it was the second-biggest bank to fail since the Federal Deposit Insurance Corporation (FDIC) started keeping records in 1934. The bank’s large holdings of government bonds lost value as the Federal Reserve rapidly hiked interest rates.

At the same time, as funding for start-ups became scarcer, more SVB customers began withdrawing their money. The source of the problem was an investment portfolio that lost value, a common occurrence in banking.

Signature Bank, New York: With $110 billion in assets, it was the fourth-largest bank failure in the US. Signature was one of the few mainstream banks to seek out deposits of cryptocurrency assets. Crypto assets lost value rapidly after the collapse of the FTX crypto exchange. A criminal investigation followed. Worried depositors started pulling out. A greedy decision to pursue a new asset class caused the downfall.

First Republic Bank, San Francisco: With assets of over $200 billion, this bank catered to wealthy clients, which helped it grow deposits rapidly. It used those deposits to make large loans, including jumbo mortgages, when interest rates were at historically low levels.

When the interest rates started to increase and inter-bank borrowing cost went up to 5 per cent from a low of nearly 0 per cent in March 2022, the bank faced a situation where its cost of doing business went up and up. The bank’s business model turned sour.

Heartland Tri-State Bank, Kansas: This was a classic case of fraud. The CEO of this modest regional bank with $139 million in assets was charged with embezzling funds to make unauthorised crypto investments that tanked. Failure of internal control caused the damage.

Citizens Bank of Sac City, Iowa: This small regional bank with assets of $66 million collapsed when the loans it had made to the commercial trucking industry turned bad. This was the result of “significant risk banks take by becoming overly concentrated and reliant on a single industry.”

Advantage India

The story is the same, in 1906 or 2023. We cannot predict when or why or which private bank will fail; but there is failure that blows out periodically. With an experienced and diligent regulator, the Indian banking industry is far more robust than in other parts of the world.

We have a system in India predominantly served by government-owned banks, with nearly 60 per cent share of deposits mobilised. The depositors in India rest easy without worrying if their banks will fail. I would argue that state-owned banks should reclaim the market share in both lending and deposits that they have lost, reversing the trend of many years, through competitive superiority.

Stability and certainty of the banking environment, anchored in state ownership, will contribute more to economic growth, than an ideological prescription towards privatisation.

The writer is Group CEO, RK SWAMY HANSA. Views expressed are personal

Related Topics